The case for a soft landing

0:06Pushkin. In the past 18 months, we've had this very fun debate in financial markets. Is the economic landing going to be hard or is it going to be soft? And, you know, this matters, right? When you have high inflation and high growth, the central bank, the Federal Reserve, they raise interest rates, brings down both inflation and growth. But which one does it bring down first? Do we get inflation back to that 2 % target without a catastrophic crash in growth? Or does that crash in growth come first and then bring the inflation down? It really matters which way it goes. And it looks more and more like we're heading toward the better version of that, the soft landing, inflation coming down gently without growth crashing.

0:48Today on the show, we discuss three indicators for a soft landing and just one against. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu here in the New York studio, joined as ever on Tuesdays by hard landing expert Katie Martin, who, as I understand, has been falling off walls, bikes, buses, trains, all forms of transportation. People seem to find it very funny when bad things happen to me. There was a time I cycled into a canal that people thought was hilarious and I did not. That's for a whole other episode. Landings, yes, I fell off a climbing wall in January.

1:30That hurt quite a lot because I broke my ankle. And then a few weeks ago, I was distracted by a really nice dog while I was running and I fell over and hurt my knee. So I know about landings. These are both stories in which I think you look good, though, because on the one hand, you're doing the trendy sport that is rock climbing. On the other, you're looking at a cute dog, which I mean, that makes you, you know, really the victim in that story. I just need to fall over less, I think, generally. Today, though, Katie, we are not talking about your hard landings. We are talking about the US economy's soft landing, which looks more and more like it could be coming.

2:03And today we've got three indicators that suggest that it may indeed be coming. And just one reason for a little bit of caution. Katie, I think we have to start with inflation, right? Landings are sort of all about inflation. Usually what happens in a cycle is the economy gets overheated, inflation is running hot and growth is running hot. So the central bank needs to raise interest rates to lower demand. That has a tendency of bringing down both inflation and growth. And the question is, do you get inflation back to a target, something like 2 % without a really devastating downturn in growth?

2:37And, you know, I think the most important point of progress there is where's inflation? Because that's ultimately what you're trying to achieve if you're the central bank. And, man, it's fallen quite a bit. Like people will have heard the headline number in the US, 3%. A lot of that reflects energy prices, which have come down in quite a big way. But I think one interesting way of looking at it, Katie, is you look at the median CPI component, right? The CPI, the consumer price index, it's all these different prices. What's the very middle one, right? The middle CPI component was 7.9 % in February.

3:08More recently in June, it's come down from 7.9 % to 4.4%, which is not 2%, but that's a lot of progress. Yeah. It doesn't matter where you are on the kind of long running argument about whether the Fed is going to nuke the economy. You cannot get around these inflation numbers. Somehow they've actually managed to pull this off. They've managed to get inflation much, much closer to target, pull it right down. We can argue about whether that was really them or whether it was something else. But anyway, the point is inflation has come right back down just as the Fed has finished with like more than five percentage points of interest rate rises.

3:47It might have one more to come, but let's see about that. This has all managed to happen without crashing the economy. And the Chicago Fed president, Austin Goolsbee, put it quite nicely the other day. He was saying the job for the Fed is to stay on the golden path where inflation comes down without causing a recession. And we're on the golden path, Ethan. Learn to love the golden path. Austin Goolsbee's been getting into Buddhism recently. He's learning about the eightfold path for the economy, the noble truths that will bring us to soft landing. So what's interesting to me is that, well, lots of interesting bits here, but one interesting bit here is that the investment community, like the universe of investors that are out there, whether they are institutional or retail or whatever they are, have also learned to love the golden path.

4:39They, you know, for months, ever since October, actually, stocks have been pushing higher, risky assets have been pushing higher in price. And there's been a large number of people who've just been saying, this is a bear market rally. Don't believe it. Don't believe it. Well, you know, 28 % later on the S &P 500 since October, it really feels like a point where there's a big capitulation going on. And people are absolutely throwing in the towel on that bearish view. And there's something in the air in markets now where the mood is really turning. And we'll get to the market reaction a bit more in a second, a little sneak preview for the listener.

5:20But I want to move to the second indicator, which is GDP, which is growth, which in inflation-adjusted terms in the second quarter came in at 2.5 % annualized. That's not a roaring economy by any means, but it's a perfectly healthy one. And it's also no longer just the consumer. In the second quarter, we got a one percentage point boost from capital expenditure. So companies are investing too. That to me, you know, it's really quite honestly quite surprising that you're getting a capex number that strong with interest rates at 5%. But it seems people are spending, companies see how healthy consumer spending is, and they're responding to that by investing in capacity.

5:59Listen, if people keep buying, you got to keep selling. And that's keeping growth, again, not booming, but perfectly healthy. Yeah, I think it's really important to make a distinction, right? So the idea that we might achieve, and it looks like we are achieving a soft landing rather than a hard landing, i.e. horrible, massive recession that involves lots of job losses. A soft landing does not mean rapid growth. Right, right. That's a very good point. It still means that the economy is not like, you know, rah, rah, go, go, go. It still means that growth is like, okay, you know, normally we'd be sort of disappointed, but right now we'll take it.

6:34So I don't think you should run away with growth expectations. And if anything, if growth did explode higher, growth rates did explode, then we might have the opposite problem, which is that inflation would pick back up again and the Fed would have to get a big red pen marked rate hike back out of the cupboard and start at it all over again. And then we really are in trouble. So we don't want that. No, that's exactly right. I think the path to a soft landing has to involve... The golden one. Don't forget it's golden.

7:06Excuse me. a period of below trend growth, a period of subdued but not crashing growth. And is 2.4 subdued arguable? I don't feel strongly either way. It probably needs to come in a little bit softer, but it's at least in the ballpark. But yeah, that's the path, right? It's consumption slows, growth slows, but not in a devastating way. Inflation comes down as both a result of all the supply chain issues we've had in the past couple of years starting to work their way out. And we've seen a lot of progress there, though I'll say it's not 100 % solved. And so you have better supply, a small tick down in demand, and hey, there's your soft landing.

7:44Yeah. And most importantly, you haven't fried the jobs market. You haven't left loads of people out of work. Yes. So I think this brings us to our third indicator for a soft landing, which is consumer confidence. Never, ever bet against the US consumer. This is the moral of the story. And consumers have been absolutely relentless this cycle. But the number here, it comes from the University of Michigan. They do this monthly consumer sentiment survey. It's risen 39 % year over year and 11 % month over month through July. And I think the really remarkable thing is how depressed consumer sentiment was, despite the fact that consumer spending has been so strong for so long.

8:22And there were periods in the past year or so when you had softness in business investment, softness in capital expenditure, softness in the housing market, softness in manufacturing. But there was one part of the economy, one leg that stayed sturdy. And that was, as you said, Katie, the mighty US consumer. And that's even when consumer sentiment was depressed. They didn't give a crap. They just kept spending. Is there a statue anywhere to the mighty US consumer? I feel like there probably should be. It's called the Apple store. One thing that comes out of all this is that, you know, as we were saying, markets have been doing very well.

8:59There's a little part of me, maybe it's because I'm a slightly miserable Brit who keeps injuring herself in stupid accidents, as previously discussed, that makes me think, is this all a bit much? So we've just had five months of gains in the S &P 500. It's the longest rally, I guess, in those terms since the summer of 2021. July pumped out more than 3 % in gains. And if you look at options markets where you go to protect yourself against horrible things happening, effectively the cost of insuring yourself against a big drop in the S &P 500 is tiny now. So the market is just like investors have got their fingers in their ears.

9:39La la la, everything's fine. You know, what war in Ukraine? What potential for a recession? you know what chance that inflation comes roaring back they're just not taking out this insurance if you like so you know Bank of America was saying this is the these are the cheapest puts you're like ever likely to have seen so it's the cheapest you know cost of insuring yourself against horrible things happening to your portfolio pretty much ever and they're saying use it you know just take out that little bit of insurance just in case and so there is a part of me that thinks okay Everyone was super bearish going into this year.

10:15We're now in August. It's already August. I don't know how that happened, but we're in August and everything is rosy and lovely. And there's this kind of, yay, everything is awesome thing going on. And you just wonder whether everyone's run from too far on one side of the ship to too far on the other side of the ship. That's a great point. It's worth remembering that just a couple of months ago, I mean, we were talking about is the debt ceiling going to cause a catastrophic panic? Like is recession right around the corner? Is just all this worry, worry, worry. And like you said, we've gone from fear to greed and like cut time.

10:50Yeah. The market tends to get ahead of itself. That's really like in some ways it's a built in property. It's a job. It's a job. Yeah, exactly. The stock market is there to get ahead of itself. But, you know, a lot of bad news has been priced out. I think, you know, because recession calls were just everywhere and gloom was everywhere for so long, investors have forgot that there's a such thing as a middle ground. you know, where like, again, growth's going to come in fine in a soft landing. Not great, but fine. What does that mean for corporate profits? Corporate profits are going to be just okay.

11:22You're not going to get a lot of amazing beats or fantastic guidance. You're going to get profits that are fine, you know, and that might not be a recipe for stocks going up forever. It's been widely noted that a lot of the rally in the last couple of months in US stocks has come from what's called multiple expansion, which is investors look at how much profit a company makes and they say, this stock is worth 10 times earnings, 15 times earnings, 20 times earnings. And that multiple depends on the investor's view of the company's prospects far into the future. Those multiples, that kind of subjective estimate from investors has driven almost all of the stock gains we've seen so far, as opposed to actual organic growth and corporate profits.

12:03Profits are flat to down. The companies haven't got better. It's just that more people People are willing to throw money at them. Exactly. Exactly. And that gives some reason for caution at this juncture in the market. But I want to move, Katie, to just one more indicator, which at least from a macroeconomic perspective, why maybe it's a little too early to be saying 100 % soft landing. And that's the labor market, right? The labor market is still way out of balance. There are still more demand for workers than there is supply for workers. And that's a problem for the central bank. It's a problem for the Federal Reserve.

12:37Because at the end of the day, if there are too few workers in the economy, that keeps the labor market tight, that keeps wage growth high. And the Fed thinks that shows up in inflation, specifically non-housing services inflation. So, you know, one way that's popular to measure the tightness of the labor market is this measure called the jobs workers gap. And it shows the difference between how many jobs are out there that employers want to fill minus how many workers are there in the labor force to fill those jobs that need to be filled. So if you've got a big gap, that means there's way more jobs than there are workers to fill those jobs.

13:11And a smaller gap means that it's a little more closer to balance. So Goldman Sachs has a nice measure of this. They put the gap at 3 million. That's 3 million more jobs than there are workers versus the 2 million that Goldman thinks is consistent with 2 % inflation. So by Goldman's reckoning, we're still at least a million workers short of where we need to be to get that real proper soft landing scenario. Yeah, I mean, at the risk of kind of mumsplaining here, you know, if we don't have enough workers, then effectively companies are going to have to pay more to get more workers. And then you get more and more wage growth.

13:44Then that feeds into the rest of the kind of inflation puzzle, if you see what I mean. And then we're back to square one. So not enough workers is not a good thing. Ethan, have you thought about working harder? Maybe maybe you're the problem. I've been trying to work a million times harder. You do need several jobs, to be fair. We get our money's worth out of Ethan. This is true. I have at least two jobs as both podcaster and newsletter writer, but I have a third job and that has taken us to long short. We'll be back in a moment with my third job. Welcome back. This is long short, that part of the show where we go long a thing we love, short a thing we hate.

14:22Katie, I'm long robber barons. You are? I was visiting a very nice estate in upstate New York over the weekend. that was once owned by Jay Gold, the US railroad magnate back at the Gilded Age. What a name. That's superb. Right? Jay Gold. Yeah, G-O-U-L-D. I didn't know terribly much about this guy. I think I'd heard about him in history class, but I was reading into some of his business ventures back in the day, and he made a killing doing speculative investments in railroad stock back when that was hot. And he had this hilarious business war with Cornelius Vanderbilt, where Gold and some of his co-conspirators bought into this company called Erie Railroad and issued fraudulent shares that were sold to Vanderbilt, like$7 million worth, which he lost all of that money.

15:10And then the fight ends up in the New York state legislature over should the fraudulent stock be legalized or not. Gold shows up at the Albany Statehouse with 500K in cash, just starts handing it out to representatives in the Statehouse. Political corruption was just so much different back then, and I love it. I think we should bring it back. It's more honest, don't you think? That does sound like it was better quality. Yeah, for sure. It's right there in the open. There's no dark money, none of this stuff. It's very plain. It's light money, bright money. So I am short. People who leave glass on the roads putting punctures in my bike tires, I'm extremely grumpy with all of them, a hex on all their houses.

15:51That is it. On a related note, I'm about to go on a long holiday. Oh, fun. So you won't see me or hear from me for a little while. I'm sure you will look after the podcast without me, Ethan. Please don't have any hard landings while you're on long vacation. You might not come back from it. Okay, I promise I won't. We need to get you like some knee pads and like a really nice helmet so that all your landings are soft. That's what I think. Knock it off. Just leave me to go on holiday. All right, Katie, please enjoy your time off. Listeners, we'll be back sans Katie Martin on Thursday for another episode of the Unhedged podcast.

16:22Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 90-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.

17:07Hey, listeners, I realized I mispronounced Jay Gould's name as Jay Gold. It is Gould, though he probably did have a lot of gold.